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This one can be a tricky one to forecast as companies combine depreciation with other accounts. It’s common for it not to show up on the income statement and can be combined with amortization and other non-cash expenses on the cash flow statement.

Look in the footnotes for disclosures on what depreciation methods the company uses and the average life of assets. Some companies may also elect to break out their plant, property and equipment into separate categories which helps with forecasting.

The depreciation expense in any given year is made up of two components, the depreciation on the existing PP&E and the depreciation on any new CapEx. Also keep in mind that the existing depreciation base can be reduced through the sale of assets which you need to track down from the cash flow statement.

Troubleshooting

Problem

Solution

Depreciation is not shown on the income statement

Look on the cash flow statement and the footnotes

Depreciation is combined with amortization and other non-cash expenses on the cash flow statement

Look in the footnotes for amortization expenses and subtract them from the depreciation expenses. Add a plug if required to match up the numbers

I don’t know what CapEx will be

Look at management guidance provided in the MD&A and research reports. You can also forecast the CapEx based on historical CapEx (cash flow statement) and grow it with revenues

Can’t determine where sales of PP&E are

Look on the cash flow statement under investing activities. Anything to do with lease back transactions usually means a sale of assets.

Example: Cisco Plant, Property and Equipment

Step 1: Create a new sheet for PP&E. Include the intangible assets on this sheet as the calculations for depreciation require the amortization schedule. Link the historical amounts from the balance sheet.

Step 2: Depreciation is not broken out on the cash flow statement so we will calculate it by subtracting amortization. Link the Total depreciation, amortization and other non-cash items line item from the cash flow statement.

Step 3: Cisco allocates the amortization expense to operating expenses and cost of sales. This information is provided on page 52 of the FY2010 annual report. Link the operating expenses from the income statement and enter the cost of sales figures from the AR. You’ll note that there were impairment charges of $28mm, $95mm and $33mm for fiscal 2010, 2009 and 2008 respectively. These have already been included in the amortization expense as noted in the AR.

Step 4: Estimate the depreciation expense for each of the years by subtracting total amortization from the non-cash expenses. Note that impairment of goodwill would also be included in this account, but the AR notes that there were no impairment charges for goodwill, hence the omission of this line.

Step 5: Calculate historical PP&E.

The starting PP&E will be the previous year’s balance.

CapEx is linked from the cash flow statement.

Depreciation is the estimate that was calculated.

The other line item is to reconcile the differences between the ending balances and the balances for the next year.

Step 6: Forecast the PP&E. There are no indications from management that they plan on increasing CapEx so keep we’re going to keep the CapEx expenditures constant and estimate depreciation.

Step 7: Link the ending PP&E to line 9 and the estimated depreciation expense to line 21.

Step 8: Calculate historical intangible assets.

The starting Intangible assets will be the previous year’s balance.

Purchases can be found by looking on page 50 of the 2010 annual report. For the years 2008, 2009 and 2010, Cisco outlines the companies purchased and what portion of the assets go to the intangible assets line.

Link the amortization from the estimated calculations.

As with PP&E, we are going to use an “other” plug to reconcile differences.

Step 9: Forecast the amortization expense. The amortization expense for the future years is provided by Cisco on page 52 of the annual report, but they do not split how it is allocated to COGS and operating expenses. Enter the total amortization expenses in the forecast.

Step 10: The amortization allocated to COGS is a function of revenues so we are going to look at historical trends. Link the net revenues from the income statement and calculate what percentage amortization makes up.

Step 11: We are going to straight-line the amortization percentage and calculate a forecast cost of goods sold for the amortization expense. From this, the operating cost amortization expense and the non-cash expenses can be forecast.

Step 12: Forecast the intangible assets. We do not know of any possible acquisitions so that line will be left blank.

Step 13: Link the ending intangible assets to line 10.

Step 14: Link the amortization operating expense back to the income statement.